What Factors Help Determine the Market Value of a Commercial Property?
Commercial real estate is almost always a good investment opportunity, especially for developing areas.
However, most investors encounter problems in having an idea of how much a certain property should be worth. This is because unlike residential properties where the value is only determined by the condition of the home itself, there are many more considerations that determine the value of commercial property.
These include the state of things like the plumbing, heating and roof and many more. Commercial real estate investors can ask for the help of a licensed appraiser, however it’s always helpful to know how it is done to at least get an idea of the value of commercial property before buying it.
One of the main factors that determine the worth of a commercial property is its location. A good location usually boils down to proximity with other commercial facilities like shopping malls, apartments, condominiums, etc. and its accessibility. Tenants of commercial properties will benefit more from renting a property that is closer to other establishments, their suppliers, employees and most importantly, their potential customers. Locations that meet the above qualities of a good location are called prime locations. These are usually commercial locations in the heart of cities.
Potential for Income
Commercial properties that have a higher potential for generating income are also valued more. For example, the more space it has for tenants, the more potential for income. This property will also be valued more. Another example for this is that a commercial real estate for office spaces that are located in central business districts have a large potential for rental and thus will also be valued more.
How Do You Determine the Market Value of a Commercial Property?
There is no single way of determining the value of commercial property. Specifically, there are different valuation approaches that licensed appraisers use in doing these. Some of these approaches are more appropriate to use for some commercial properties than others and it is the appraiser’s prerogative in mixing and matching these approaches to get to the right value of the commercial property.
This is the simplest and most intuitive approach in determining the value of a commercial property. It is simply the cost of the land plus the cost of the building’s construction. This is basically the same as of determining the value of a residential property. It is simple and straightforward but it has a disadvantage of not being able to take into account the potential of the property for generating income.
In this valuation approach, the value of the commercial property depends on its potential income and its cap rate. The cap rate is defined as a property’s net annual rental income divided by the current value of the property. Its equation is the net operating income divided by the cap rate.
A market study for the sales of similar properties in the same neighbourhood are collected to get the cap rate. The resulting cap rate is then adjusted based on your property’s specific features. You can make it higher or lower if your property has certain advantages or disadvantages for your tenants. Usually, this adjustment does not go beyond half a percentage point.
This approach has the advantage of being able to consider its potential for income and recent sale activity of similar properties. It can also be adjusted for certain factors through the cap rate.
Sales Comparison Approach
This approach basically just uses the market prices of available similar properties in the market. This approach usually starts by listing the detailed characteristics of your commercial property. These can include the number of floors, rooms or commercial spaces per floor, floor area, lot size, etc. The next step is then to find the prices of current listings of properties in the market that have similar characteristics.
This approach has a disadvantage that it is not very accurate. For example, even though your commercial property has similar characteristics with one that is available in the market, it may also still have features that are unique to it. An experienced appraiser, however, has the skills and knowledge to adjust the market values for similar properties to accommodate for unique features of your commercial property.
Gross Rent Multiplier Approach
This approach is similar to the income approach, but it depends on the annual gross rents rather than the net operating income. It is also then multiplied to the gross rent multiplier rather than the cap rate. The gross rent multiplier can also be determined from similar properties in the same location.
Gross rent multiplier is a number that is greater than 1 while cap rate is a number less than 1. It is different from cap rate because it disregards expenses. Also, it excludes physical condition and potential upside due to below-market rents.
Value Per Door
This approach is applicable in determining the value of apartments that are of the same quality. The total price of one property is divided by the number of apartment units that are available to get the value per unit or door. This number is then used to determine the price of a similar apartment with a different number of available units. The number of available units on another property is multiplied to the value per door to get the total value of the property.